Weak Theories About the Weak Dollar

Surprise! Eight-plus months into 2017, the dollar is among the weakest currencies globally. After rallying last year—and the vast majority of the time since 2013—the dollar, on a trade-weighted basis, is down -8.2% through September 15.[i] Predictably, pundits who fixated on the strong dollar before now assume the “weak” dollar is the be-all, end-all markets story. Some presume the weakness is a prelude to a stock decline. Others argue it is sure to goose certain sectors and assets. And sure, there is some influence. But put into proper perspective, currency gyrations just don’t mean as much as investors often presume.

Theories abound over currency effects, but most are half baked. If strong-dollar bears are consistent,[ii] a weak dollar should be bullish. The argument is large US multinationals—much of the US market by capitalization—benefit because their foreign sales (in foreign currencies) translate into greater revenue and profits when converted back into dollars. More earnings = good, right? But this is too simplistic. Among other complications, multinationals typically hedge foreign exchange exposure. Good management is well aware currencies fluctuate. Occasional references to exchange rate impacts at earnings releases are most often excuses,[iii] in our view. But what’s more, multinationals’ supply chains often extend globally. A weak dollar also means rising import costs crimping margins (when insufficiently hedged).

That aside, most pundits now argue the weak dollar and rising stocks are sending conflicting arguments. Weak dollar bears suggest the greenback’s slide reflects Trump’s stalled agenda. And since many presume currency markets are smarter than stock markets, clearly stocks must fall once they fathom the weak dollar’s warning signals. Across the pond, this argument is perhaps even more well-established: Many point to the pound’s post-Brexit vote fall as a cautionary tale, saying higher import prices squeeze household consumption and raise overall inflation risks. But this ignores import prices’ limited influence on US (and UK) consumers’ purchasing power.

But whether you think the weak dollar is bullish or bearish, don’t overrate it. Stocks hardly mind the dollar—weak or strong. You might find that hard to believe, given popular discourse’s current fixation on exchange rates. But consider:

2011, 2012 and 2013 were quieter on the currency front if you simply look at the yearly percentage change—up 1.7%, down -1.4% and up 2.6%, respectively.[vii] Perhaps that’s surprising, given rampant fears around the euro’s viability at this time! Either way, small currency moves didn’t stop the bull—the S&P 500 rose 56.8% over this span.[viii]

2015: Dollar up 10.3%, stocks up 1.4%.[x] The second-straight annual surge had many fearing currency wars (such as with the yuan) would throttle Western growth and kill profits, taking stocks with them. While it wasn’t a great year for equity markets, the bull persisted.

2016: Dollar up 4.4%, stocks up 12.0%.[xi] The dollar continued rallying alongside stocks, although currency fears seemingly took a back seat to the election.

So let’s sum it all up: During this stretch, the dollar was weak in two complete years and the current nine-ish months (2009, 2010 and 2017). Stocks rose 26.5%, 15.1% and 13.3% in those three periods. Moreover, foreign stocks led in two and lagged in one. There was a relatively calm dollar period from 2011 – 2013. Stocks rose bigly over this span, although the first year was flattish. And there were three years of a strong—occasionally quite strong—dollar from 2014 – 2016. Stocks rose all three years, albeit barely in 2015. The only consistency since the recession ended is that while the dollar rose and fell, the bull market bucked on.

In the last bull market (2002 – 2007), the dollar was pretty much uniformly weak. Yet that didn’t bode ill for US stocks. Neither was it rocket fuel for US stocks on a relative basis—they overall lagged. Neither of today’s weak dollar arguments—bullish or bearish—would have been much help in assessing that cycle. Then again, if-then theories rarely, if ever, explain markets, so that shouldn’t shock. Stocks and currencies are both highly liquid markets, so they price in all widely known information and beliefs. They react to the same news in real time, but they move on different drivers. Plus, they aren’t hermetically sealed. Stocks are aware the dollar has been weak, and investors already acted on it. Those cheering or jeering dollar moves are just overrating currency markets’ power and underrating stocks’ ability to digest currency moves. You can’t determine stock direction from currency markets—dollar movements aren’t automatically bullish or bearish. Don’t overrate them.